Most of us are familiar with three types of Isa: cash, stocks, and junior Isa.
But did you know that there are three other types, each with different rules and risks?
Young people under 40 are helped to save for a house; another is to invest in lenders; and the third is for buying the smallest shares in the stock market and grabbing a potential advantage to avoid estate taxes.
It is not easy to determine whether these alternative Isas are right for you. So here’s a handy guide to help.
Does this suit us? Think carefully about whether a Lifetime Isa is right for you
Lifetime Isa – for a 25% boost to house deposits
Launched nearly six years ago, a Lifetime Isa can be opened by those 18 or older, but under 40.
You can deposit up to £4,000 each tax year and earn a 25 per cent government bonus up to a maximum of £1,000 per year.
The £4,000 counts towards your annual Isa allowance of £20,000. If you wish, you can save in one money and one shares and shares Isa in addition to the account.
However, there are strict rules about how to spend the money you save.
- You can use it to buy your first home, but it shouldn’t cost more than £450,000
- Or you can leave the jar untouched until you turn 60
- And you can only contribute to it until you’re 50
- There is a huge fine if you break these rules
Withdraw the money before age 60 for anything other than a home and you’ll get a 25 percent fee. This destroys the government bonus and eats away at what you have saved.
For example, on a £10,000 pot, £8,000 would come from your out-of-pocket contributions and £2,000 from the government bonus (assuming no interest or growth).
A 25 per cent penalty would mean you lose £2,500, so the government bonus plus £500 from your own savings.
A handful of providers offer Lifetime Isas, but none of the major banks do. The best rate is 3.5 percent from digital company Moneybox. You can also opt for a stock version.
PRONUNCIATION: The surcharge of 25 percent is attractive if you are saving for your first home. But you have to be sure you’ll use it for that – or you can wait until age 60 to access the money. Otherwise, the fine will be so high that it is better to use an ordinary Isa or pension.
Innovative Finance Isa – for peer-to-peer investing
There is a special Isa for savers who want to put money into so-called peer-to-peer (P2P) loans.
The likes of RateSetter and Funding Circle take customer savings and lend money to individuals or businesses.
There are some similarities with banks, but P2P companies are more loan matchmakers than lenders themselves. And they don’t have the huge overheads that a bank has.
The idea is that both savers and borrowers get better rates by cutting out the bank intermediaries.
Option: For example, RateSetter and Funding Circle take customer savings and lend money to individuals or businesses
P2P loans have been around for over 15 years and you can save tax-free with an Isa wrapper since 2016.
However, adoption of Innovative Finance Isas (IF Isas) has been muted. This is partly because P2P lending is riskier than putting money in a cash Isa. You can lose your capital if a borrower does not pay or defaults on their loan. In addition, your savings are not protected by the Financial Services Compensation Scheme, which covers bank deposits of up to £85,000.
Some companies offer as much as 9 percent returns, but beware: the higher the risk, the higher the rate.
Some IF Isa providers have gone out of business in the past. And market leader Zopa pulled out of peer-to-peer lending altogether at the end of 2021 to focus on banking.
PRONUNCIATION: Do your homework if you are tempted. Treat this as an investment where there is a risk of losing all your capital. Best for more experienced investors who like to experiment with a portion of their portfolio.
Target Isa – for IHT planning
This is a specialized Isa that can only hold stocks listed on the Alternative Investment Market (Aim).
Often referred to as Britain’s ‘junior’ stock market, Aim is home to thousands of high-growth technology, healthcare and environmental companies.
Success stories include tonic maker Fever-Tree, package holiday retailer Jet2 and video game support company Keywords Studios, each now worth more than £1 billion.
This is essentially a twist on the standard shares and shares of Isa and you get the same rules for the £20,000 tax-free Isa benefit and benefits of tax-free income and growth, but qualifying Aim shares offer an inheritance tax break.
After two years of owning the shares, you should be able to pass them on without paying Inheritance Tax (IHT).
The trade-off is that Aim-listed companies are risky, with no guarantee of success; many fail.
But if you use Aim Isas for tax planning, the portfolio’s value must fall 40 percent more than other investments to negate the IHT benefits.
You can choose your own stocks or have a ready selection done by an Aim Isa specialist such as Octopus, through a financial advisor or broker such as Wealth Club.
Beware, not all Aim companies are eligible for the IHT-free benefits.
PRONUNCIATION: Only for experienced investors. Talk to a financial advisor to find out if this type of account is right for your needs.
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